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Monday, Feb 25, 2002

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Vision 2020 -- Managing globalisation

THE YEAR 2001 edition of the annual series, Human Development in South Asia, which has just been released, starts with a quotation from its founder, the late Mahabub ul Haq: "Globalisation is no longer an option but a fact.

Developing countries have either to learn to manage it far more skilfully, or simply drown in the global cross currents." That has proved difficult even for a country like Germany.

Globalisation, which is founded on the principle that free trade is best for economic growth, suffers from all the ills of free competition. One, the principle itself suffers from an in-built self-contradiction. Pure competition is like the black widow, a species of spider that kills and gobbles its mate immediately after copulation. Likewise, pure competition systematically eliminates inefficient producers.

Left unchecked, the process can continue until no competitors are left and the most efficient producer becomes a monopoly, or at least a few of the best, become an oligopoly. Thus, a pure free market destroys the very foundation of its own existence.

As a remedy, we have market regulators. Unfortunately, no self-optimising rule has yet been discovered to guide regulators. Therefore, they have to operate by instinct, by guesswork and be content with uncertain compromises. However honestly they may try, regulators cannot avoid being arbitrary in some way or other. As the Enron case has demonstrated, even at best, regulatory systems are liable to collapse now and then.

Second, just as it eliminates the inefficient producer, the free market hurts also the inefficient worker. In an unbridled market, competent workers are over-rewarded, and the less competent and the outmoded ones are driven to the wall. That increases economic disparities, makes the rich richer and the poor poorer.

Progressive tax has been the conventional remedy for this situation. Indira Gandhi pursued her objective of Garibi Hatao ruthlessly by imposing a marginal rate of taxation of 98 per cent. She levied also wealth tax. The two together raised tax levels beyond 100 per cent. That only led to tax evasion and no increase in tax collections. Thus, even such a massive dose of progressive taxation did not help her government to help the poor. That story has been repeated in all socialist countries.

As a reaction, Arthur Laffer argued that, like zero rate of taxation, 100 per cent taxation too would yield nothing, or next to nothing. Hence, tax collections will be maximum at some optimum rate that lies somewhere in between zero and one hundred per cent. That optimum rate is usually so low that social activists will not accept it as progressive enough to mitigate economic disparities. Hence, a tax rate that maximises tax income and minimises tax evasion, does not suffice to mitigate economic disparities.

Third, when inefficient businesses close down, many innocent workers are thrown out of jobs. Ultimately, some may find other jobs but not all of them do. Even those that do, succeed only after a painful time lag. Apart from the human suffering such forced unemployment entail, it also reduces economic efficiency by not utilising fully all available human resource.

To correct this situation, developed countries use some form of social net or other. Unfortunately, the safety net is a palliative, not a remedy. It does not create employment; it only makes unemployment somewhat bearable. In addition, it comes into effect only after the disease sets in and not before. Further, unlike the market, which eliminates inefficient producers, the safety net has no in-built mechanism to eliminate free riders. In many countries, safety nets have led to a vicious circle — unemployment benefits encourage the unemployed to become free riders. That slows down, or even prevents, economic recovery. In consequence, unemployment increases even more.

Preventing monopolies is a primary issue with globalisation. Unfortunately, there is no error-free system of market distribution. If competent firms are discouraged from expanding, inefficient firms will get undue protection. If efficient firms are not checked, they will monopolise. In this imperfect world, as a thumb rule, we may accept that monopoly forces will kill competition if any one firm acquires more than 20-25 per cent market share. On the other hand, if firms are restricted from taking over even 10-15 per cent market share, the benefits of free market are likely to be lost. On this assumption, free competition may be allowed until no single firm has more than 10-15 per cent market share. Beyond that stage, large firms may be penalised, and small firms encouraged, in such a manner that no firm finds it worthwhile to monopolise the market.

In India, the Government has tried to keep monopolies in check by reserving some products for small-scale industries. That has led to inefficiency, poor quality, and to corruption. The reservation policy has satisfied none — neither small- nor large-scale industries, not even the customers. It has also made Indian industry internationally uncompetitive. So, reservation is not the answer.

Neither tax penalties based on market shares will work: Such figures can be fudged easily. The best option is to identify some strong features that distinguish small industries from large ones, and devise penalties based on those differences.

Two such features are employee remuneration and expenditure on publicity. Unilever, one of the largest multinationals in the world, spends nearly 15 per cent of its sales on publicity but invests less than 2 per cent of sales on research. Such firms also pays such fat salaries that many competent persons are dissuaded from taking up more challenging jobs in smaller firms. Both ways, such allocation of near-monopoly profits is undesirable.

It would be beneficial if additional taxes were levied on publicity expenditure and on salaries/ perquisites above the average. In general, such additional taxes will impose a handicap on large monopolising firms without affecting smaller ones. If that tax is suitably designed, small industries will acquire a relatively level playing field; large firms will be deterred from using the profits they derive from their dominant position to become monopolies. Then, the much-flawed mechanism of reservation for small firms can be dropped without hurting them.

Next, we have to find a better alternative than safety nets to help those who lose jobs when inefficient firms close down. Safety nets have failed mainly because they are managed by governments and not by competitive markets.

Suppose unemployment insurance is privatised, and every worker is required by law to take unemployment insurance, in the same way all car owners are required to take insurance. In that case, competitive firms will inevitably relate the premium they charge to the expected risk of that individual's unemployment and to the person's re-employable skills.

Such a variable premium has several benefits.

One, it becomes transparent which kind of jobs and skills pose least risks. Two, the attraction of lower premium for up-to-date skills will induce many to modernise their skills continuously. Three, insurance firms will have a vested interest in finding alternative employments for those who lose jobs. It is also easier for them to locate new jobs than for individuals to do so on their own. Four, the costs free riders now impose will not fall on an impersonal and ineffective government but will be shared by other unemployed persons. They will surely generate a social pressure against free riding. Above all, the expected reduction in unemployment is a social good of inestimable value.

Globalisation has created yet another problem by increasing income disparities. To a large extent, that problem will be mitigated when, as suggested above, excessive wages are taxed, and unemployment insurance too is made effective. Public goods are also helpful in this regard because they help the poor and the rich equally, but relative to their income, they help the poor more than do to the rich.

Currently, it is fashionable to privatise many public services like building roads. That way the responsibility for collecting user charges is transferred to private parties. That does help the poor indirectly but not directly. For the poor to benefit substantially, transfers from the rich to the poor should increase. The government is supposed to do so by collecting taxes. It has proved to be a poor intermediary.

The Government is fully aware of this failing. Hence, it offers tax deductions when businesses and rich persons contribute to charitable works. Suppose similar benefits under what are known as 80 CC and 80 G schemes are allowed for all expenses incurred on all public services such as construction and repair of roads, water supply, street lights, particularly waste disposal. In short, devise rules and tax benefits to encourage businesses and the rich to donate municipal services. There is an interesting precedent for it — the City of London operates on those lines, and even profits from doing so by making the City such an attractive place that investors flock in from all over the world. Every crop comes with weeds.

The solution is not to halt cultivation but to remove weeds as fast as they grow. Likewise, the remedy for the ills of globalisation is not to give it up but to find innovative ways of mitigating its evils.

The author is former Director, IIT Madras. Response may be sent to:

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